Source: Norfolk Southern.
The railroad industry has never been stronger, and Norfolk Southern (NSC -3.60%) has cashed in on the advantages of rail transport compared to more costly and less energy-efficient alternatives. Investors have been extremely confident about the sustainability of its big bull run, sending its stock to all-time highs repeatedly during 2014. Yet even with a lot of things going for it, Norfolk Southern still faces some challenges that could hold it back from further record highs. Let's take a closer look at some of the reasons why investors should remain cautious about Norfolk Southern and what to keep an eye on going forward.
1. Norfolk Southern will have to follow competitors and increase capital expenditures.
The railroad industry can be highly capital-intensive, with expensive locomotives and railcars and the need to maintain thousands of miles of tracks. With a lot of train engines reaching a point where continued operation is more costly than it's worth, many railroads are looking at investing in new equipment in order to keep up with efficiency-improving innovations and reduce operating costs. For instance, Berkshire Hathaway's (BRK.B -0.68%) Burlington Northern Santa Fe said just last week that it would spend $6 billion in 2015 to improve its capital-equipment base to serve its customers, with $1.5 billion going toward projects to expand its network's reach and much of the rest going to replace or upgrade track and add more than 300 new locomotives to its existing fleet.
For its part, Norfolk Southern's expenditures were more modest than those of BNSF, but the $2.2 billion it planned for 2014 still represents a huge portion of the roughly $12 billion in total revenue that Norfolk Southern brings in annually. No matter the cost, though, customers will demand state-of-the-art equipment and infrastructure, so Norfolk Southern won't have much choice but to keep up with its peers and their capital-spending efforts.
Source: Norfolk Southern.
2. Falling energy prices could let trucking make a comeback against railroads.
Drivers have loved the recent drop in gasoline prices, letting them spend less at the pump to get where they're going. For Norfolk Southern and its peers, though, fuel costs are a double-edged sword. On one hand, fuel costs make up a significant portion of the overall operating expenses for Norfolk Southern, making savings beneficial to its bottom line. On the other, cheaper fuel also makes transportation alternatives like trucking more economically feasible, posing a potential long-term threat to railroad growth.
It's always possible that some incremental business will move toward other nodes of the nation's intermodal network if energy prices continue to drop. Nevertheless, Norfolk Southern and its railroad peers have done a good job of establishing broad-based intermodal shipping options of their own, and satisfied customers won't necessarily jump ship
3. Norfolk Southern's slowing growth could lead shareholders to jump ship.
Norfolk Southern's third-quarter results didn't produce much enthusiasm among long-term shareholders. Even though Norfolk Southern set new records for the third quarter in revenue, net income, earnings per share, and operating ratio, a weak coal market held back growth, with total gains of 7% in operating revenue falling short of what more optimistic investors had expected.
Source: Norfolk Southern.
The main question facing Norfolk Southern and its investors is whether the weakness in sales will prove to be temporary. Coal demand has been a big wildcard for the railroad industry generally and for Norfolk Southern in particular, but the company has worked hard to try to diversify its exposure into areas beyond coal and reduce its reliance on fossil fuel in order to drive its results. Those efforts haven't eliminated coal entirely from the list of important segments that Norfolk Southern pursues, nor is it ever likely to, given the company's geographical focus. That doesn't have to be the kiss of death for Norfolk Southern, but it could nevertheless hold back some of its growth opportunities and cause short-term pain for the stock if shareholders sell out in a mass exodus.
Norfolk Southern has performed extremely well, and the company still has many favorable factors supporting its future growth. Nevertheless, these three issues could put a roadblock in front of Norfolk Southern's future prospects, at least temporarily.
